The U.S. labor market looks strong in spite of macroeconomic uncertainty. Nearly 2.3 million jobs were added between January and June, and unemployment has held steady at 3.6% since March. That has been a tailwind for human capital management (HCM) specialist Paycom Software (NYSE: PAYC).
Paycom reported strong earnings after the market closed on Tuesday, beating Wall Street’s expectations on the top and bottom lines. Revenue climbed 31% to $317 million, and non-GAAP (adjusted) earnings rose 30% to $1.26 per diluted share. Better yet, management raised full-year guidance, calling for revenue growth of 28% at the midpoint in 2022.
After that strong showing, is this growth stock a buy?
Simplifying human capital management
Paycom’s cloud HCM suite helps businesses manage their employees from hiring to retirement, without the cost or complexity of on-site solutions. Its core product is payroll software, but it also offers adjacent applications for talent acquisition, employee learning, and time and labor management.
Paycom has distinguished itself in two key ways. First, all of its software products are built on the same system of record, so administrators only have to enter employee data one time. By comparison, many businesses rely on a patchwork of point solutions to address their HCM needs, meaning administrators regularly waste time maintaining employee information in several systems.
Second, Paycom has infused its software with self-service functionality, allowing employees to update and maintain their own data through a mobile app. That further reduces the administrative burden, allowing administrators to spend their valuable time elsewhere.
Beti (Better Employee Transaction Interface) is a great example. As the industry’s first self-service payroll software, Beti effectively automates payroll processing by requiring employees to review and approve their paychecks prior to submission. That ultimately improves accuracy, meaning administrators spend less time resolving issues after payroll has been run.
Keeping customers happy
Each year, Paycom reports its annual revenue retention rate, a metric that tracks the percentage of revenue retained from existing customers. That provides insight into how satisfied customers are with its HCM software.
Paycom’s value proposition — a broad set of tools built on a single system of record — plays a large role in keeping retention high. But the company also provides high-quality support to its clients. A dedicated specialist is assigned to each Paycom customer, fostering a personalized relationship that makes its HCM platform stickier.
Additionally, Paycom has successfully moved upmarket in recent years. The company targeted organizations with up to 2,000 employees in 2017, but that figure ticked up to 5,000 employees in 2018 and 10,000 employees in 2021. That’s important because larger businesses tend to be more stable, meaning they are less likely to go out of business or be acquired.
Thanks to those factors, Paycom has seen its retention rate climb consistently over the last three years, evidencing the value it creates for clients.
Annual Revenue Retention Rate
Currently, management believes Paycom has captured about 5% of its growing addressable market, meaning there’s plenty of room to run. To capitalize on that opportunity, Paycom is expanding its sales force. It added five new offices (and counting) in the last few months, and management plans to continue densifying its presence in new and existing markets.
It typically takes a year or two for new offices to get up to speed, so investors should look for the new offices to contribute significantly to total sales by 2024.
A recession could mean trouble
Paycom makes money through fixed fees (per software product) and variable fees (per employee). That means the company would struggle if unemployment were to spike, simply because revenue would drop as its customers reduced headcount. And given the state of the economy — inflation is at 40-year high and the Federal Reserve is raising interest rates at an aggressive pace — a recession is possible in the near term, which would almost certainly mean higher unemployment.
However, the labor market still looks strong right now. There were 10.7 million job openings in the U.S. in June, but just 5.9 million unemployed individuals. In other words, there were almost two jobs available for every unemployed person.
On that note, Paycom stock currently trades at 17.3 times sales — slightly cheaper than its five-year average of 19.5 times sales. The company has a valuable software suite, a solid growth strategy, and a history of executing on its larger market opportunity. From that perspective, investors should consider buying a few shares of this growth stock today.